No Fun With Numbers: Dow Jones Below 7,000
Bad news, economy fans. This morning the Dow Jones Industrial Average crossed from the eighth to the ninth circle of financial hell…
Investor concerns about financial companies and worries about Friday’s unemployment report continued to erode the markets on Monday as the Dow Jones industrial average fell below 7,000 for first time since October 1997.
The government on Monday morning agreed to provide another $30 billion to the insurance giant, American International Group, which also reported a $61.7 billion loss. On Friday, Washington took a larger stake in Citigroup.
(Just imagine the scene if AIG were still in the Dow Jones Industrial Average.)
Anyway, this statistic today is exceptionally horrible, because 7,000 is one of the magic numbers that the Dow is never supposed to cross, ever, for the simple reason that we have all agreed to freak out about 7,000 instead of 8,000 or 6,500 or 5,973.
On the bright side: thirteen years from now, when the Dow inches up past magic number 312, people will be dancing in the streets.
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A credit default swap is an insurance on debt, typically a municipal or corporate bond. It is essentially the same sort of thing as mortgage insurance on a house when you owe more than 80% of the house’s value to the bank. To make it worse companies, like Lending Tree, were selling high risk mortgages bundled together as “mortgage bonds” which could have fell into the same boat as municipal and corporate bonds with the same credit default swaps.
Whether its corporate bonds, municipal bonds, or mortgages, its the same problem: AIG has to pay off on the debit insurance it sold to because so many are defaulting at the same time. Its just like when homeowner’s insurance companies go bankrupt after natural disaster because they can’t pay all the claims at once.
My point is, I think we are reaching a point of diminishing returns. Its like my P.O.S. Dodge Dynasty. Sure, its really nice not having a car payment, it’s a good commuter car, and it gets decent mileage. But when I put $1500 into repairing it in two months, I’d be better off buying a new car and junking the P.O.S. There’s a point where the Treasury either needs to say, “You are not too big to fail” and lets them fail or says, “You are so far gone that the only option is to take over, seize your properties, and do your job for you because there is no viable way to rescue you because it would be cheaper to start over from scratch.”
Sure, buying equity stakes in the company gets the company some much needed cash. But it doesn’t fix the underlying problems of the company. Just as putting new shocks improves the ride of my P.O.S. but it doesn’t fix the oil leak.
What does happens when the government buys equity in the company is it dilutes the market value of all the remaining shares of the company because it creates more total shares of the company. So the market has to have a drop big every time the government takes a bigger stake in a company because the government in essence just devalued the market.
I'm all in favor of doing something. But what I see being done isn't fixing any problems. Taking over the underlying debt and making it so that the call on the insurance payoff is diminished would help AIG on a more fundamental level than simply handing them a pile of cash.
@bearness: It probably is, but according to a radio program I heard last night, the specific problem with AIG was that it sold, like, $426B in credit default swaps to European banks, which would thus go down if AIG went down. At which point Timmy G. would be stuck, because what is he going to do, bail out those Socialists in Europe?
Ain't figured out yet that this is just a big fleecing of taxpayers to enrich the already rich.
Time for violent revolution…
I’m beginning to think this “taking a stake and becoming a shareholder of the company” philosophy is crap. That $700 billion that went into TARP could have bought 28 million mortgages with an average face value of $250,000. I don’t know how many toxic mortgages there are out there, but that would have taken care of a fair chunk of them and then AIG wouldn’t have to be insuring them. And the Treasury could have restructured them and the restructuring wouldn’t be seen as a loss because they bought them at face value.
Hmmm…. Maybe the Treasury should have done what it was tasked to do instead of what it wanted to do.